One of the most technological advancements that occurred during the 20th century was the widespread use of electric power. As power distribution moved from locally based generators to a massive, intertwined and interconnected grid that spanned the entire U.S. continent, industrial plants were set free from the constraints of having to be established in close proximity to power sources. During this time, electric power migrated from luxury, to necessity and today, is currently traded on the open market as a commodity by pioneers such as Mirant.
One risk that electric power producers face is a forced outage of one of the producer's generation facilities. The main risk of a forced outage is that the forced outage will occur while power prices are high and the power plants will not be able to generate electricity. This prevents the power producer from collecting the associated profit from the power during this period of outage. In addition, to supplement the loss of electricity, the producer must seek an alternate source and pay a price determined by the market at the time of the forced outage. Therefore, many power producers are interested in purchasing insurance that will reimburse them when their power plants experience a forced outage at the same time that power prices are above a certain price. Insurance companies are not able to issue insurance to cover a risk unless a model is created that will predict the liability associated with an outage of a power plant.
Therefore, there is a need in the art for an approach to insure event risks while also calculating an appropriate hedge amount.